1. Slide 10.1 Invoice 4E1 Project Management Specification & Costing - 1

2. Slide 10.2 Key Concepts Project specification Elements of project cost Fixed, variable and semi-variable costs Direct, indirect and overhead costs Absorption costing Variance and standard cost Allocation

3. Slide 10.3 Reprise: Project Specification What is to be done or produced Common issues Lack of proper planning No written specification Unforeseen problems Need for modifications Absence of change control

4. Slide 10.4 Project Specification States what is to be delivered, using: Design drawings Performance requirements Operating characteristics Tolerances Layout Also states when it is to be delivered May include cost estimates Must be sufficient for purpose

5. Slide 10.5 Project Specification - Documents Documentation is important Documentation system: binders, files, archives Clear labelling Coding Schedule of documents Descriptive text Supporting documentation Distribution list Methodologies specify documents to be produced E.g. Prince 2 (http://www.ogc.gov.uk)

6. Slide 10.6 Project Costing Questions How much will/did it cost to do/build/make? Can be difficult to answer Issues Different types/sources of cost Primary, subsidiary and hidden costs Allocation of cost to multiple activities Spreading costs over time Recovery of costs or elements of costs

7. Slide 10.7 Question: How much does this lecture cost?

8. Slide 10.8 Fixed & Variable Costs Fixed costs Constant, whatever you do e.g. buildings, fixed contracts, management Variable costs Depend on how much you use e.g. part-time labour, concrete Semi-variable costs Part fixed, part variable. e.g. truck rental, power Project versus production costing

9. Slide 10.9 Cost Behaviour Variable costs (not necessarily linear) Fixed costs Semi variable Volume Cost

10. Slide 10.10 Cost Classification TypeReasonExamples Direct costsIncurred directly on project Lubricants Labour Semi-direct costsConsequence of work on project Project management Insurance Quality control Indirect costsKnock-on effect of project on other areas Disruption to other projects Loss of production Overhead costsGeneral admin and other overheads General management time Accounting Personnel

11. Slide 10.11 Total Cost Tertiary Costs Secondary Costs Primary Costs Decreasing Visibility

12. Slide 10.12 Finance, tax Administration Senior management Disruption to other processes, Plant, Power Labour, Materials, Contractors Project Cost Impact

13. Slide 10.13 The Problem of Prediction Likelihood of data being captured accurately Certain Remote IT Finance Sales Marketing Production Distribution External Disbenefits... Internal Disbenefits... Overheads... Learning … Training … Installation Acquisition Pre-acquisition -2 -1 0 1 2 3 n Time Organisational Impact Cost Heading Project Start

14. Slide 10.14 Primary and Secondary Costs Primary cost items Labour Raw materials Power/energy Plant and machinery Buildings Consumables Contractors Secondary costs Professional advice Legal (including patents, planning fees, etc.) Management overhead Insurance Many minor sources

15. Slide 10.15 Costing Methods Several approaches to costing And different ways of computing costs give different results Four important methods are Full absorption Marginal/decision/contribution Standard Activity-based Poor costing can lead to: Incorrect estimating Incorrect pricing Poor decisions

16. Slide 10.16 Absorption Costing Also known as full and traditional costing cost = direct cost + overhead 1. Decide what overheads are to be absorbed: All (total absorption costing) Some (contribution costing) 2. Decide the basis for allocation Labour hours? Machine hours? Other? Which overheads, and how much of each?

17. Slide 10.17 Absorption Costing General Overhead Dept. allocation Dept. allocation Project allocation Project allocation Project

18. Slide 10.18 Absorption Costing: Example Period 12345 Project 1Labour hours 100 75 Rate/hour 25 27 Labour cost 2,500 2,025 Materials 1,000 1,200 1,000 - 2,000 Subtotal 3,500 3,700 3,500 2,025 4,025 Overhead 1,333 1,600 1,714 1,333 Total Cost 4,833 5,300 5,100 3,739 5,358 Project 2Labour hours 200 150 100 150 Rate/hour 30 28 32 Labour cost 6,000 4,500 4,200 2,800 4,800 Materials 5,000 6,000 3,000 600 Subtotal 11,000 10,500 7,200 3,400 5,400 Overhead 2,667 2,400 2,286 2,667 Total Cost 13,667 12,900 9,600 5,686 8,067 Overhead 4,000 Overhead allocation based on labour hours

19. Slide 10.19 Absorption Costing Example Overhead allocation based on labour plus material costs Project 1Labour hours100 75 Rate/hour25 27 Labour cost2,500 2,025 Materials1,0001,2001,000 -2,000 Subtotal3,5003,7003,5002,0254,025 Overhead9661042130814931708 Total Cost5,4665,9425,8083,5187,733 Project 2Labour hours200150 100150 Rate/hour30 28 32 Labour cost6,0004,5004,2002,8004,800 Materials5,0006,0003,000600 Subtotal11,00010,5007,2003,4005,400 Overhead3,0342,9582,6922,5072,292 Total Cost19,03418,90012,6006,2868,667 Overhead4000

20. Slide 10.20 Variance Deviation from expected outcome; when actual cost ≠ planned/theoretical cost Sources Price variation Time overrun Scope change/Specification change Allocation base Analysis of variance Where did the variance arise? Why did it arise? What must be done now?

21. Slide 10.21 Variance Variance is important It can be favourable (good) or unfavourable (bad) Budgeted cost of screeding €53,000, actual cost €54,320 Variance (unfavourable) (€1,320) Hard to pinpoint cause when multiple sources e.g. rate and hours, multiple materials, overrunning and overspending Beware the lure of favourable variance

22. Slide 10.22 Project 1Labour hours100 75 Rate/hour25 27 Labour cost2,500 2,025 Materials1,0001,2001,000 -2,000 Subtotal3,5003,7003,5002,0254,025 Overhead9661042130814931708 Total Cost5,4665,9425,8083,5187,733 Project 2Labour hours200150 100150 Rate/hour30 28 32 Labour cost6,0004,5004,2002,8004,800 Materials5,0006,0003,000600 Subtotal11,00010,5007,2003,4005,400 Overhead3,0342,9582,6922,5072,292 Total Cost19,03418,90012,6006,2868,667 Overhead4000 Absorption Costing Example In this example, there is no overall variance, but there is variance in projects. This is the original position as shown in the earlier slide.

23. Slide 10.23 Project 1Labour hours80 6080 Rate/hour25 27 Labour cost2,000 1,6202,160 Materials1,0001,0011,0021,0031,004 Subtotal3,0003,0013,0022,6233,164 Overhead857889117717421478 Total Cost5,4665,9425,8083,5187,733 Project 2Labour hours200150 100150 Rate/hour30 28 32 Labour cost6,0004,5004,2002,8004,800 Materials5,0006,0003,000600 Subtotal11,00010,5007,2003,4005,400 Overhead3,1433,1112,8232,2582,522 Total Cost19,03418,90012,6006,2868,667 Overhead4000 Beggar My Neighbour… By being efficient, Project 1 transfers overhead cost to Project 2

24. Slide 10.24 Summary Costing problems often start with poor specification e.g. ‘scope creep’ There are common cost elements in all projects Costs can be analysed as: fixed, variable, semi-variable direct, indirect Absorption costing is a common method of costing But is not without problems The concept of variance is central to financial management of project costs